On 28 July 2022, the ESAs published a report on the extent of voluntary disclosure of principal adverse impacts under Article 18 of the SFDR (the "Report"). Ultimately, this Report is helpful for any FMPs complying with the PAI disclosure requirements under Article 4 of the SFDR, not just those that have voluntarily opted-in.
Section 3 of the Report provides good examples of best practices, and less good examples of voluntary disclosures, along with recommendations to the EC and NCAs. Some of the examples of best practices include descriptions of PAIs, credible decarbonisation objectives, and show efforts towards consideration of PAIs while acknowledging the lack of data in certain fields. These examples and recommendations should be considered preliminary, and will be further developed in subsequent reports. Additionally, the ESAs plan to provide further guidance on the implications for due diligence disclosures, along with voluntary disclosures under Article 7(1) SFDR in future reports.
As mandated by the EC in a letter dated 28 April 2022, the ESAs have announced that they will consider their findings in their review of the PAIs framework, and that the EC may consider their findings in any preliminary evaluation on the functioning of the SFDR. By way of reminder, the EC has requested that the ESAs submit any amendments to the PAI framework within 12 months following the receipt of the letter, meaning by 28 April 2023.
On 11 July, the Platform on Sustainable Finance (“PSF”) published the Draft Report on Minimum Safeguards, which advises on the application of minimum safeguards ("MS") in relation to the Taxonomy Regulation ("TR"). The Draft Report focusses on four core topics for assessing compliance with the MS – (i) human rights, (ii) bribery and corruption, (iii) taxation, and (iv) fair competition.
It should be noted that the report is only in draft at this stage. The PSF is inviting stakeholder feedback until 6 September 2022 to finalise and submit the report to the EC by later this year. Although the EC is not bound to follow the report's recommendations, it provides welcome clarity for FMPs aiming to comply with the MS.
Article 18 of the TR aims to prevent green investments from being labelled as 'sustainable' when they involve negative impacts on human rights including labour rights, corrupt practices, non-compliance with taxation regulations, or anti-competitive practices. Resultantly, Article 3 of the TR specifies that economic activities must be carried out in compliance with the MS in order to qualify as environmentally sustainable.
SFDR and the Minimum Safeguards
The Draft Report also refers to the SFDR, which is explicitly referenced in Article 18(2) TR, the objective of which is to bring the ‘do no significant harm’ (“DNSH”) disclosures under SFDR in line with the MS requirements in Article 18(1) TR. Accordingly, the Draft Report suggests that FMPs assess alignment with the MS through the use of the five mandatory social PAIs. Of the five PAIs, four topics are already covered in the MS and while the PAI relating to controversial weapons is not covered, the PSF confirm that any such exposure means that an investment cannot be TR-aligned because of its non-compliance with the DNSH principle under the SFDR.
Ultimately, compliance with the MS and the guidance in the Draft Report should therefore achieve compliance with the mandatory social PAIs for the purposes of performing the SFDR’s DNSH test. This is subject to the PSF finalising its recommendations on the MS in the final report.
The Draft Report recommends assessing the four core topics through a procedural test and an outcome-based test. The former includes having adequate corporate due diligence processes for human rights, and aligning them with the UN Guiding Principles ("UNGPs") and OECD guidelines for Multinational Enterprises. This involves the company reporting on its policies and procedures on the four core topics, and putting in effective policies to act on the identified PAIs.
The outcome test involves considering final court convictions in relation to the four core topics as a sign of non-compliance with the MS. Additionally, the report considers lack of collaboration and non-compliance with National Contact Points, along with non-engagement with the Business and Human Rights Resource Centre with regards to allegations raised against the company.
The procedural considerations that the report recommends for each core topic are:
Human rights, including labour rights: Has the company established adequate due diligence processes? This would include taking into account jurisdiction-specific human rights risks, addressing known risks within the relevant sector, and effective company reporting.
Bribery and corruption: Has the company developed adequate controls and compliance programmes for preventing and detecting bribery?
Taxation: Does the company treat tax governance and compliance as important elements of oversight, and are there adequate tax risk management strategies?
Fair competition: Does the company promote employee awareness of the importance of compliance with applicable competition laws? Additionally, does it train senior management in relation to competition issues?
The Draft Report suggests that the status of non-compliance should be upheld until the company can prove, for example through an external audit, that it has implemented an improved process of due diligence that makes future violations unlikely.
Further recommendations and considerations
The Draft Report recognises that there are still gaps that need to be further considered. Further work is required in relation to treating different convictions in various jurisdictions where many human rights violations are not prosecuted or are state-led.
Authored by Rita Hunter and Paida Manhambara.